The Ultimate Guide to Small Business Finance

Business loans, lines of credit, banks, credit unions and alternative lenders are all pieces of the business finance pie. And that’s before you get into rates, collateral and duration. With so many products on offer, it can be hard to know where to start when your business is looking for finance. Luckily we’ve put together a cheat sheet with all the financial facts you’ll need when looking for business finance.

What is a small business loan, and how does it work?

A business loan is a single sum of credit given to a business by a lender. Defined as a debt-based financing arrangement, a business loan is often used to fund investment and growth, or to cover unforeseen operating costs. To apply for a business loan, a borrower submits an application to a lender. To determine how much credit can be offered, the lender will evaluate aspects of the business like revenue, profit and credit score. Since a business loan is a fixed amount of finance, it suits companies that know exactly how much credit they need.

Like a standard loan, a small business loan is repaid to the lender over the course of an agreed period of time. The loan is paid back with interest and, sometimes, other fees.

What is the difference between a business loan and line of credit?

A line of credit , on the other hand, is an arrangement with a financial institution that gives a business access to a maximum amount of credit – sort of like a credit card or overdraft. Borrowers are granted access to a certain amount of credit (for example, $5,000), but are not obliged to use it all.

The main advantage of a line of credit is its flexibility. Businesses can tailor what they withdraw from their credit line to their needs (known as ‘drawing down’). For example, if cash flow is tight one month, a business can dip into their credit line to boost it. Interest is paid only on the amount a business spends, not on the entire credit line they were approved for. Each drawdown from the line of credit becomes a separate business loan.

How do I apply for small business finance?

There are several ways of applying for business finance. Firstly, you can make an application to a traditional institution (like a bank) by going into a branch and meeting with the relevant advisor.

Secondly, you can apply for a loan through a broker, advisor or accountant. In this scenario, you provide an intermediary with information about what you’re looking for and they will connect you with a suitable lender. Intermediaries – especially brokers – tend to earn a commission from the lender through connecting you.

Thirdly, you can apply for a loan yourself online. This is a service offered by some banks and most alternative lenders.

How much information does a business lender require?

Practices vary amongst lenders, but a lender may ask for several pieces of information about you and your business. Firstly, a lender will want to know how much credit your business needs. From your side, this requires a well-considered budget corroborated by financial projections.

Secondly, you may be required to disclose what you need the business loan for. This helps the underwriters who will approve or deny the request.

Thirdly, a lender may ask for a cash flow report and an industry risk report, as well as how long you have been in business. Sometimes, your personal credit score will be considered.

How much time does it take to get finance?

This varies between lenders. In the case of traditional lenders like banks or credit unions, you may wait between four and six weeks for a decision. With alternative lenders, the application process tends to be faster. Some alternative lenders purport to offer a credit facility within one working day.

What’s the difference between interest rates and APR?

When it comes to loans, interest rates and APR (annual percentage rate) are often found in the same sentence. While both terms refer to how much a loan will cost you, they are comprised of different things. The interest rate is simply how much interest you’ll pay in addition to the amount of credit (the ’principal amount’) you’re repaying. It’s expressed as a percentage of the principal, and can be quoted as a yearly or monthly rate, though the latter is less common.

Also expressed as a percentage, the APR gives you a more comprehensive idea of what you’ll repay to a lender. It includes the (annualised) interest rate, amortization rate, plus fees like the origination or arrangement fee.

For example, if the APR on your $10,000 loan is 7% (5% interest + 2% origination fee), you’ll repay $10,700 in one year.

Does business finance require collateral?

Some lenders require collateral and some don’t. A secured business loan – the type usually issued by a traditional lender – tends to be tied to an asset, such as a piece of real estate, machinery or a vehicle. Security can also be in the form of a personal or director’s guarantee.

Collateral offers a lender a degree of protection when they provide a credit facility. An unsecured business loan isn’t tied to an asset. Instead, a lender will base the amount of credit and the corresponding interest rate on the performance and creditworthiness of a business. In lieu of collateral, business loans tend to have higher interest rates.

What is a short-term business loan?

A short-term loan is a loan with a duration of one year or less. However, typically, short-term loans tend to paid back more quickly than this – usually within 90 to 120 days. Short-term loans are popular with small and medium-sized businesses that need quick capital infusions to boost cash flow, cover unexpected expenses and finance outstanding loans.

Which business needs is small business finance most suited to?

Due to their nature, short-term business loans suit growing companies that need fast capital boosts. These companies may need more cash to gear up for a new contract, purchase inventory or take on more staff. They may also use loans to bridge gaps between invoices being paid and to prepare for a busy season.

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